What is Staking and how does it work?
What is Staking?
Staking or PoS (Proof of Stake) is a method of cryptocurrency "mining" where users hold their digital currency and get rewarded instead of using computing power like PoW (Proof of Work). In return, they receive rewards based on how much time they have held onto their Crypto and how much of that Crypto they are holding. It is a more climate-friendly version of mining. Regular mining like the type Bitcoin uses takes a lot of computing power and energy/resources. Staking allows you to earn a percentage back on the Crypto you decide to stake and instead of needing graphics cards and high-powered computers all you need to do is lock your Crypto into staking which puts your Crypto to work.
Proof of Stake can get a little complicated so I am going to try to explain it the best I can.
Proof of Stake works similarly to Proof of Work but without having to use high-powered machines to solve complex problems. The more you stake and the longer you have your Crypto staked the more you will make and the reason behind this is that the Crypto you are staking is making sure transactions are legit and everything is running smoothly. The network chooses validators (Someone staking or Mining) based on the size of their stake and the amount of time they have been staking. The most invested reap the most rewards. If a transaction in a block is found to be void then a certain amount of the rewards by that validator will be burned by the network. This is known as a slashing event.
Staking and mining use something called a consensus mechanism which can either be POS (proof of Stake) or POW (Proof of Work).
Bitcoin uses Proof of Stake to keep a ledger of all incoming and outgoing transactions. This still takes a good amount of computing power, especially with the demand growing for Bitcoin. Some Blockchains used to use Proof of Work but as demand increased and more projects started getting created and growing, Proof of Work was incapable of handling the growth of the network such as Ethereum.
Ethereum used to use Proof of work but with growing demand and the amount of information flowing through this Blockchain Proof of Work was not working the way it was supposed to. Ethereum not only needed computing power for transactions for Ethereum but also for multiple other Crypto projects that run on the Ethereum Blockchain. Not only that but also the whole Defi world. This started causing congestion which ended up causing slower transaction speeds and higher fees. This is one of the main reasons Ethereum decided to switch to Proof of Stake.
Definitions of Staking and Mining
Proof-of-stake (PoS) is a consensus algorithm that requires users to stake their own cryptocurrency rather than using proof-of-work (PoW). PoW algorithms use computing power to solve complex math problems, while PoS algorithms rely on the user’s holdings. PoS algorithms are considered more secure than PoW due to the fact that no central authority is required to validate transactions.
Rewards vary depending on the coin being staked. Some coins offer higher rewards for longer staking times, while others reward holders based on the number of transactions processed. Users who stake their coins earn interest on their holdings, and the amount of interest earned varies depending on the coin.
Mining is the process of adding transaction records to the blockchain ledger. Miners verify transactions and add them to the public distributed ledger called the blockchain. Miners are rewarded with newly created cryptocurrency for verifying transactions.
The difference between Mining and Staking
Proof of Work needs a good amount of computing power and the hardware and energy needed are overwhelming and grows as more people use the blockchain.
Proof of Stake is climate-friendly. Proof of stake allows transactions to be confirmed by people who hold the Crytpo that is being staked. The rewards from staking come from transaction fees. Using PoS on blockchain projects such as ETH you will need to set up a node. Nodes are used to keep track of transactions and help projects stay decentralized. When staking for ETH you will need to hold a certain amount of ETH and run a node on your computer. Nodes do not take a bunch of computing power.
A node is a decentralized ledger that keeps track of Cryptocurrency transactions and can be run by anyone on pretty much any type of machine.
When staking certain projects you will need to run a node on your computer so you can contribute to making sure all transactions are legit and trustworthy. Some projects do not have you run a node but these projects are allowing you to stake using their nodes. To truly stake your Crypto you will need to run a node on your computer.
The difficulty of mining refers to the complexity of the mathematical problem that miners need to solve in order to create blocks. As the network grows, the difficulty increases, making it harder to mine blocks. This is why staking is becoming more popular with Crypto investors.
Block rewards refer to the amount of cryptocurrency given to miners for successfully solving a block. Each block contains a reward that is split between miners who find the solution first.
Transaction fees are paid to miners to confirm transactions. These fees help ensure that the system runs smoothly and prevents spam attacks.
The Pros of Staking
proof of stake does the same thing as Proof of Work but without all of the computing power needed from mining. Staking is climate-friendly and is easier for the average person to implement into their earnings. Mining can be expensive because of all of the computing power and electricity needed. Staking does not use energy or computing power.
The Cons of Staking
Even though staking is more climate-friendly and easier to use for the average person it still comes with some risks. The Crypto market is very volatile and if you are staking your Crypto and the price drops then you have the chance of losing the majority of your money so the rewards do not compare to what you have lost. A good amount of Crypto projects you can stake require you to lock your Crypto for a certain amount of time which makes it so you can not sell, transfer, or exchange until the lock period is done. Also, some projects make it so that when you decide to unstake you have to wait a certain amount of time.
You can use Exchanges such as Coinbase to stake some of your Crypto without having to deal with a lockup period but the staking percentage will be a lot lower. You eliminate a good amount of the risk for a smaller reward. I think that this might be a better option for beginners. Less reward but you are free to sell and exchange your Crypto whenever you want. One thing that is risky with staking options such as Coinbase is that it is an exchange. As we saw with Celcius and FTX, exchanges are extremely risky to hold a large amount of your assets on.
I would suggest keeping your Crypto off of exchanges and on a cold wallet, this is because even though exchanges like Coinbase and Binance are huge they still run the risk of Something happening to them like the FTX incident recently. If a company can not pay its bills it can be a victim of financial collapse or Insolvency.
Cryptocurrency is not legal tender and is not backed by the government. Coinbase is not an FDIC-insured bank and cryptocurrency is not insured or guaranteed by or subject to the protections of the Federal Deposit Insurance Corporation (“FDIC”) or Securities Investor Protection Corporation (“SIPC”), and may lose value. - Coinbase
If an exchange collapses the chance of you getting your funds back is slim to none. At the moment there are no laws governing Crypto assets so if you decide to stake your Crypto on an exchange I suggest being careful and knowing the risks associated with doing so.
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